Canadian banks ordered to undergo mortgage stress tests

Canada's top banking regulator has again addressed the country's overheating housing market, demanding lenders show that their capital levels could withstand severe drops in the price of houses in Vancouver and Toronto.

The Office of the Superintendent of Financial Institutions (OSFI) has imposed more stringent criteria for stress tests, the hypothetical scenarios used to measure the impact of downturns in areas that affect banks, such as housing, employment and economic activity. The lenders will now be required to evaluate how they would be affected by a decline of at least 50 per cent in house values for Greater Vancouver and at least 40 per cent for the Greater Toronto Area.

The evaluations will test all other areas of the country will have to assume a minimum downturn of 30 per cent, in line with OSFI's previous requirements, which did not single out specific markets.

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The changes apply to smaller federally regulated lenders, such as Canadian Western Bank and Equitable Bank. It is unknown if the Big Six banks are facing similar revisions to their own stress tests, given that OSFI keeps confidential the criteria used in the stress tests for these institutions.

None of the Big Six lenders replied to a request for comment.

This is the first time OSFI has updated its real estate testing requirements for lenders since it implemented them during the 2008 financial crisis.

While stress tests are by no means forecasts for where house prices are likely to go, the more stringent testing adds to growing concern among regulators and observers that the risks surrounding Canada's housing market have grown substantially as prices have surged.

In June, national house prices rose 10 per cent year over year, according to the Teranet-National Bank house price index. However, the increases were significantly higher in Vancouver and Toronto, as consumers reacted to low borrowing rates and a shortage of homes for sale.

In response, regulators are trying to apply the brakes to a housing market that has risen even though the economy is weak and incomes are stagnant.

Earlier this month, OSFI said – in a rare open letter that acknowledged the watchdog's concerns about lending standards – that banks and other mortgage providers must increase their scrutiny of borrowers' incomes, debt levels and credit scores.

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On Monday, the B.C. government announced a plan to impose an extra 15-per-cent tax on non-resident foreigners who buy homes in the Vancouver area – such purchases accounted for about 10 per cent of the value of transactions in Metro Vancouver over the past month – a move that was applauded by Bank of Montreal's chief economist and Ontario's Finance Minister.

Last month, the Bank of Canada warned of "increased riskiness" in the mortgage industry as a run-up in household debt posed potential consequences for lenders.

Banks themselves have on occasion expressed their own concerns about Canada's housing market.

In particular, Bank of Nova Scotia chief executive officer Brian Porter said in June that the federal government should raise minimum down payments, increase the qualifying rate for five-year fixed mortgages and impose a tax on foreign buyers.

While OSFI's announcement of changes to stress testing was not addressed to the Big Six lenders – which are known as domestic systemically important banks (D-SIBs) and are tested by OSFI and the Bank of Canada – it is possible that these larger banks could face their own shifting requirements.

"As the macro stress tests for the D-SIBs are based on detailed and specific instructions for each institution, the instructions are not shared," an OSFI spokesperson said in a statement.

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